The Ultimate Currency War

After the 2008 financial crisis, the liquidity trap induced policymakers to venture in unconventional endeavors. On the fiscal front, much has been discussed regarding the effectiveness of fiscal policy to pull developed countries out of the sluggish recovery. On the monetary side, the so-called quantitative easing (QE) guaranteed the liquidity needed to avoid a collapse of the financial system, even though its efficacy to stimulate the economy has been questioned. Within this environment, some concerns were raised in the Emerging Markets. The expansionist attempts would, some have been advocating, inflict in exchange rate appreciation, hurting EM’s companies’ exports competitiveness.

Domestic Issues

The first thing is to elaborate the goals of a QE-type of policy. Roughly, there are three pillars: a) it aims to provide the liquidity needed to break the vicious circle of falling asset prices, credit contraction and banking problems; b) it also aims to induce the private sector to take some risks, since safe assets yields became very low and more resources are available; and c) it has some effects on expectations, which are crucial for understanding business cycles.

Even though there is much interconnectedness between countries, especially through financial markets and capital flow, the goals of QEs are domestic, i.e., the policymakers seek to stimulate the economy to help the recovery process (or at least to avoid the worst). Of course there may be “collateral” effects, such as the depreciation of the exchange rate (appreciation of EM’s exchange rate). Personally, I do not think this effect is on the center of the targets. The US, for instance, is a relatively closed economy, therefore it depends substantially on the domestic aggregates.

Furthermore, for the exchange rate depreciation to increase net exports - the Marshall-Lerner condition - a combination of elasticities in a certain way is need, implying that there’s more to be considered. Moreover, the improvement in developed world’s conditions translates in greater demand for EMs products. Some estimates indicate that this offsets the exchange rate appreciation effect.

Data

Comparing the end of period amount of Long Term Treasury Purchases with the real effective exchange rate index (REER), it’s hard to find an evidence of a great impact on the REER from the liquidity injection:

The appreciation trend actually diminished after the QEs and some of the subsequent depreciation was induced by the change of the exchange rate regime. Moreover, taking the log of the series and calculating their first difference, one can actually find that after the QEs the average variation was higher (though more volatile), i.e., it has induced depreciation, rather than appreciation:

Remarks

The data seems to indicate that the effect of QE on the REER is low, if any. However, since the analysis is absent of any econometric treatment, one should be cautious. Perhaps a better look could reveal other conclusions. Nevertheless, I think that neither there’s a war, nor if there is, it something really important to justify the recent policy attempts.